NY futures traded to some minor gains this week, as December advanced 77 points to close at 82.26 cents.

Since crashing through its long-term uptrend line on August 13, December has made several failed attempts to climb back above it. However, the market was unable to generate any upside momentum and December has settled the last 14 sessions in a relatively tight range of just 284 points, between 80.74 and 83.58 cents.

Average daily trading volume continued to be lackluster at just around 18k contracts and open interest was still at around 254k. In other words not much has changed since last week as volatility continues to erode, with December at just 18.7% today, which is 5% lower than a month ago. This tells us that traders are not expecting the market to make any big moves.

There seems to be a good reason for that. When we look at the current supply/demand picture according to the latest WASDE report, we have global production at 120.53 and mill use at 127.62 million bales, giving us a slightly bullish seasonal production gap of 7.09 million bales. However, the market is starting to believe that this gap is going to narrow, since global production is doing better than expected, while mill use might struggle due to problems in emerging markets.

Therefore, if the global production gap were to narrow to around 3 or 4 million bales, then prices would have no compelling reason to move much in either direction, especially since the ROW has the production surplus (currently projected at +8.91 million bales), while China has the deficit (-16.0 million bales).

China has been quite active getting rid of its Reserve stocks, as it has auctioned off over 9.6 million statistical bales so far this year. It is unclear how much cotton remains in the Reserve, but we estimate that China will lower its inventory by maybe another 5-6 million bales before it will start to rotate stocks (= sell old stocks and replace them with newer domestic/imported cotton). Once that happens, China will increasingly rely on imports to fill its domestic production gap.

Chinese imports have so far totaled around 3.8 million statistical bales for the first seven months of the calendar year. At this pace imports would reach only around 6.5 million bales for the entire year. However, China is in the process of allocating a new ‘sliding scale’ import quota for 3.67 million statistical bales, which should be distributed to the various entities next month. This somewhat higher duty quota is in addition to the annual 1% TRQ, which is for around 4.11 million statistical bales. Both of these quotas are currently competitive when compared to Chinese domestic prices and should therefore lead to increased imports.

It looks like China is gearing up for higher imports in the future, as it will sooner or later have to make the transition from relying on Reserve stocks to beefing up its imports. However, timing the potential impact of this shift is difficult. With the Chinese and all of the other Northern Hemisphere crops about to be harvested, there is going to be plenty of supply available for a while, which should keep a lid on prices until the situation starts getting tighter again next spring.

US exports sales of Upland and Pima cotton amounted to 210,800 running bales for both marketing years, with China taking 96,400 bales. Participation was lower than usual with only 13 markets buying, but that may be partly due to merchants being hesitant to commit more at this point, considering how much has already been sold. Total commitments for the season have risen to 9.2 million bales, of which so far only 0.65 million bales have been exported. Sales for the following marketing year are at around 1.45 million statistical bales.

So where do we go from here? The market has very little momentum at this point and given the statistical situation this is not expected to change anytime soon, unless something were to drastically change in the supply/demand outlook. With crops about to come off the fields, supplies should be plentiful for a while and a potentially bullish scenario will probably have to wait until the 2019 planting season.

Support remains solid from 82 cents on down, as there were still 14.75 million bales in unfixed on-call sales as of last Friday, of which 3.89 million are on December. The Indian MSP will provide additional support at around 78-79 cents. In other words, barring another financial crisis, we don’t see cotton prices collapse anytime soon either.

We therefore feel that the market will remain in a sideways trend for now.

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